Sample Answer (Unit 3 - Business Economics and Economic Efficiency)

Unit 3 (previously Unit 4) January 2006 - Question 11 – The Low Cost European Airline Market - Parts (a), (d) and (e)

a) Explain why a low cost airline company such as Easy Jet ‘typically generates all its profits in the 2^nd half of the year’ (line 6) (4)

• Demand for air travel is seasonal, with its peak in the summer months. This translates into higher revenue, which means higher profit. Also, end of year bonuses, end of year holidays lead to a peak in air travel. Vice versa, winter months are off season, thus leading to lower revenue.
• Fuel costs are lower in the summer months, as the need for fuel for heating purposes is lower

d) Examine the ability of Easy Jet and Ryanair to survive the pressures of ‘lower air fares and increased competition’ (line 17). (10)

• Both are the leaders in the market, which means they have exploited substantial EOS and thus have lower AC than the competitors. Their high profit means they can sustain losses for a longer period than their competitors, either by engaging in a price war, or refusing to reduce price at the risk of a fall in revenue.
• Evaluation : There is a danger of DEOS as the firms may experience inefficiencies as they expand, e.g. managerial slack.
• The firms are well established in the market, thus have strong, familiar brand names. Customers may have loyalty to the firms, thus enabling them to sustain revenues even as competitors slash prices.
• Evaluation : For many travellers, especially in the low cost market, price is more important than the airline.
• The firms have established networks, indicating they have borne the initial costs of establishing their networks – planes, routes, flight slots etc. This acts as a barrier to entry for newer entrants to the market.
• Evaluation : In LR, increased consolidation will mean that new entrants will compete for more and more routes. High supernormal profits will make it worthwhile to overcome the barriers to entry.

e) Assess the extent to which the European airline industry is contestable. (10)

• Contestable
• New entrants entering, indicating high contestability
• There are many firms with intense competition and falling profit levels
• Falling fixed costs – online bookings reducing the need for ticketing staff, possibility of leasing planes or second hand plane market may be a way to work around high initial capital costs.
• Non-contestable (Evaluation)
• Falling profitability and high potential EOS means eventually the market will consolidate, mergers will occur leaving a few large, dominant firms
• Bigger firms with lower AC have the ability to hold out longer in a price war
• Start up costs remain high despite possible reductions in cost mentioned above
• Strong brands and established networks may mean in the long run the bigger firms will hold out while the smaller ones price themselves out.

Like these answers? Find out more.